Protecting Your Personal Wealth as a Small Business Owner

Many small-business owners have the bulk of their net worth tied to their businesses and are not taking enough steps to protect their personal wealth, according to a recent report. In fact, research by the U.S. Small Business Association suggests that small-business owners are significantly less likely to hold retirement assets (IRA and Keogh accounts, as well as 401(k) and Thrift accounts) than private sector wage and salary workers.

This is not intentional financial neglect, of course. Building, growing and troubleshooting a business is an all-consuming commitment and owners are hard-pressed to put aside time to focus on personal wealth building. They are also driven by a fervent belief, which all entrepreneurs must have to be successful, that their businesses are going to thrive and endure. Many owners are confident that their businesses will be able to provide all that is needed for their family’s needs – and then some.

However, business owners who hold a high percentage of their net worth in their business assets are financially vulnerable, and open to potential pitfalls down the road. For instance, it’s not uncommon for an entrepreneur to enjoy a very comfortable lifestyle while business is on an upswing only to have nothing to show for it if the economy falters or their business fails. In the very worst cases, business losses can be the catalyst for personal bankruptcy and loss of house and property.

Here are several steps small-business owners can take to minimize personal risk and ensure their wealth grows in tandem with, or in spite of, their businesses.

Invest Outside the Business

If you told your financial advisor that you wanted to put all your assets into one stock, they would say you were crazy and likely warn you that by doing so you would be placing your personal wealth and your family’s security in jeopardy. Yet that’s what most small-business owners do by keeping all of their wealth connected to their businesses. According to a 2015 study of 118 business owners with at least $3 million in investable assets, personal and business wealth are deeply intertwined. More than 40% of business owners reported that most of their income and financial assets were tied to their firms. This is even more pronounced among those below the age of 50, among which more than 60% said their businesses represented most of their income and assets.

A simple first-step fix is to draw a regular salary, with a portion of each paycheck earmarked for personal savings. Then, work with a financial advisor to develop an asset-allocation strategy with diversified holdings such as stocks, high-yield bonds, real estate, commodities and structured notes. For added protection, invest in adequate amounts of health, disability and life insurance to shield your family from financial hardship should you be unable to continue working for an extended length of time.

Set Up a Buy-Sell Agreement

You might not like thinking about what would happen to your business and your family if you were to die or become permanently disabled, but preparing for that possibility is one of the smartest things you can do to ensure the financial security of both. When you have business partners, there are protections you can put in place, one of which is a buy-sell agreement — a contract among owners to buy an exiting owner’s share of the business at a previously agreed-upon price, which should be recalculated periodically as the business value grows. It is usually funded by life insurance policies, which are purchased for all partners in a business. The insurance payout provides the funds for partners to buy an exiting owner’s shares.

While you may have it set in your mind that a spouse or child would inherit your daily responsibilities, when the time comes, they may not be willing or suited for the job at hand. When properly structured, a buy-sell agreement eliminates the mad dash owners typically have to go through to come up with monies to buy out a partner, and ensures that your family is compensated at fair-market value for your share of the business.

Build Business Credit

One of the biggest mistakes successful entrepreneurs make is failing to obtain business credit and loans – not just early on, but throughout the growing stages as well. Without proper financing, a business often cannot grow unless owners continue to sink their own money into it, inhibiting their ability to invest properly in their personal financial futures.

The 2016 Small Business Credit Survey, conducted by the Federal Reserve Banks of seven major U.S. cities including New York, Atlanta, Boston and St. Louis, found that 63% of small businesses hold debt that is secured by personal assets or guarantees. Among larger and more mature firms, the same holds true: 58% of employer firms with more than $10 million in revenues, and 63% of firms that started 11 or more years ago, still use personal assets or guarantees to obtain business capital. While it takes time to build the business equity and credit track record that will make a favorable impression on banks and financial institutions, the sooner you build a solid business credit history separate from your personal credit history, the safer your family assets will be.

Verify Business Value

Nearly 40% of business owners don’t have a retirement-income strategy outside of their businesses and plan to rely on proceeds from the sale of the businesses or income generated from the business post-retirement, according to a 2015 MassMutual Life Insurance Company study. For this reason, going through the business valuation process is crucial in order to know whether there is a gap between how much you will need in retirement and at what price your business will sell. Wisely, over half of the business owners surveyed said they have had their businesses valuated in the last three years.

Small-business owners notoriously overvalue their businesses, sometimes far beyond what a realistic selling price would be. Consult with CPAs, lawyers and financial professionals that understand your industry, and identify benchmarking partners — similar firms you can compare your business against — to get an idea of whether the sale of your business will provide you with the financial cushion you’re anticipating to keep you comfortable in your later years.

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